The Third-Inning Stretch for Legacy CMBS

PrivcapRE: There’s been a lot of attention paid to the commercial real estate debt opportunity by investors and players. Could you characterize where we are in the cycle and what it means for the scale of the opportunity ahead? Robert Lieber, C-III Capital: What inning you’re in depends on what game you’re playing. In the long term, we’re in the third inning in terms of how we go through these cycles. If you go back to the 2000 time frame when the commercial-mortgage-backed-securities business (CMBS) blossomed and boomed, it was the 2005, 2006, and 2007 vintages where you saw annual issuance volume of $200-plus-billion a year, which dwarfed any prior year by a magnitude of four or five times to one. Oftentimes when you see those huge expansions, it’s like an embolism in a vein. Sometimes it blows, and that’s what happened in 2008 in the global financial meltdown. We’ve seen a significant pickup in the last three years, with annual issuance volume almost doubling each year. PrivcapRE: A lot of people are looking at 2015 to 2017, particularly for the maturities for CMBS. Is that where we’re going to see the bulk of the opportunity? Lieber: There’s going to be a lot of activity for sure, because the 10-year ’05 deals are coming due in 2015, but borrowers are trying to figure out what they’re going to do when those loans come due. We’re going to see a significant percentage of those loans not be able to refinance at par when they mature. The looming potential defaults and restructurings and recapitalizations and foreclosures that are to come are going to dwarf much of the activity from 2010 through 2013. PrivcapRE: Where is your activity at the moment? Is it in the legacy bonds coming due, or are you looking at new issuance? Lieber: We still look at new issuance, but haven’t been active participants. Our focus has historically been in the legacy trust. That’s where we have the most competitive advantage, because as a special servicer and the controlling class holder, we have a view of what’s happening in the markets and with the individual properties that secure loans. Our competitive advantage is that we have so much experience managing these trusts and know what’s happening. The new issue B-piece CMBS market’s been a great business. A lot of liquidity’s come back. We continue to look at the new issue B-piece markets, but there’s competition out there that may not understand the risks they’re stepping into for the types of returns they think they’re getting. PrivcapRE: Do you look at any particular food group in legacy bonds? Lieber: One of the advantages of these trusts is this great diversification, at least theoretically. We look carefully at each trust and the loans that make up that trust; we look even more carefully at the assets that underlie those loans to get an understanding of an individual property’s ability to pay on the loan. There are some scary things out there today in some of these asset classes. Retail is tough, and if you have a regional mall in a secondary or tertiary market, that’s a loan that’s difficult to get any confidence about paying off. PrivcapRE: What will CMBS issuance be in 2014? Lieber: I don’t think it’s going to be $160 billion. If you go back three years it’s moved from $20 billion to $40 billion to $80 billion. There’s been a backup in the market so far this year in on-the-run rate pace. But you’ll see volumes exceed what we did last year, in no small part because there’s so much opportunity to refinance—and then the question’s going to be the price. PrivcapRE: What’s the number one question an LP should be asking a GP when it comes to debt investments? Lieber: The big issue in debt investment today is how volatile the market is. We’ve seen huge swings in relative value. You talk about where the opportunity is, whether you’re buying up or low in the capital stack to hit your target returns. The window moves so quickly that it’s difficult to put together a fundraising effort to raise sufficient capital to pursue a narrow strategy. The question is how far you as a GP will go to chase deals, to meet the criteria you’re talking about, and whether you’re prepared to shut the fund down if you don’t see opportunities that meet the objectives you started with. PrivcapRE: Part of the problem is that it takes a long time to get LPs into an opportunity. Has the opportunity already gone away by that point? Lieber: That’s exactly right. If it’s a broad strategy, then you have more time to raise the money, and the returns may be lower, higher, or at least on target, but not when you realize it, because the markets move so quickly. We’ve seen success in keeping the fund sizes small, doing a quick raise, pursuing a specific strategy. And if you can’t find deals that you like, then you stop investing money and start liquidating the assets.